ABS: A Checkup on the U.S. Consumer | Lord Abbett
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Market View

Keeping an eye on trends in consumer debt and auto loans—and their implications for related U.S. asset-backed securities

Read time: 4 minutes
 

In the March 29 Market View, we surveyed potential factors that could influence the performance of U.S. securitized products such as asset-backed securities (ABS), especially amid a newly strengthening U.S. economy. With the recovery now in full swing, we thought it would be a good time to check in on some key indicators for consumer-linked ABS investments in sectors such as credit cards and auto loans.

A Turn in Revolving Debt

One indicator that has captured our attention is the level of U.S. revolving consumer debt—primarily via credit card borrowing. Figure 1 shows that after a sharp pandemic-led drop, revolving credit is inflecting higher. Nonetheless, May 2021 levels were still down about 5% versus the year-earlier month, which was early in the pandemic, and 10% versus May 2019.

 

Figure 1. Recharging: U.S. Revolving Credit Is Bouncing Back
Year-over-year percentage growth in U.S. consumer borrowing by category, January 31, 2017–May 31, 2021

Source: U.S. Federal Reserve of St. Louis FRED database. Data as of May 31, 2021 (latest available). For illustrative purposes only.

 

The decline in revolving debt came as consumers have lightened up on spending, especially within the travel and leisure category. Less debt, of course, equals stronger balance sheets for U.S. households. By and large, we believe that consumer debt levels are healthy right now, which bodes well for an increase in spending down the road as the U.S. reopening continues.

Auto Loans Find A Higher Gear

In the earlier Market View, we examined trends in prime and subprime auto loans, using a proprietary report that sifts through millions of loans. At the time, it appeared that the pressure on the loan market had eased as stimulus and reopening effects began to take hold. Fast forward to the end of May 2021, and conditions have improved even further.

Look at Figure 2, which displays some key metrics from a proprietary universe of ABS transactions we monitor, capturing approximately $180 billion in loan balances. We consider this data a major window into real-time performance of the loan market. Loan extensions are currently running at 2.3% of issued loans; pre-COVID-19, we were typically seeing loan extension rates at 3.6%. Other metrics, such as three-month default rates and loan-loss severity measures (which track the percentage of a defaulted loan balance not recovered), along with the number of loans either 30-plus or 60-plus days past due, have also strengthened beyond pre-COVID-19 levels.

 

Figure 2. Key Auto-Loan Metrics Are Stronger than Pre-COVID-19 Averages
Data (in percent) as of May 31, 2021

Source: Lord Abbett Internal Indices, Intex. Data are latest available. A subprime auto loan is a type of loan used to finance a car purchase that's offered to people with low credit scores or limited credit histories. Prime auto loans are offered to borrowers with higher credit scores and stronger credit histories. Auto loan extensions represent the percentage of loans under which the lender has agreed to let the borrower pay a lower loan payment or not make a payment for a certain time period. Default rate=Three-month constant default rate (CDR), the percentage of loans within a pool of auto loans in which the borrowers have fallen more than 90 days behind in making payments to their lenders. Severity=The amount of loss associated with each default as a percentage of the defaulted balance. For illustrative purposes only.

 

What’s behind this strength? Surging used-vehicle prices are being supported by ongoing new-vehicle, supply-chain issues, pushing some of the demand to used vehicles, and consumer strength buoyed by stimulus payments and the recovery in the labor market. Both higher prices and improving consumer balance sheets are contributing to the decline in auto loan-delinquency severity levels. Much as with our view on inflation generally, over the medium term, we expect these pricing pressures to subside as the supply chain normalizes and near-term consumer stimulus diminishes, all while sales rates return to pre-COVID-19 levels. 

What We’re Also Watching

In addition to debt levels and loan metrics, we have been watching broader trends that affect the U.S. consumer. We have been monitoring the expiration of the special unemployment insurance (UI) programs enacted under U.S. government stimulus plans. There has been some concern that, as the programs expire at different dates in various U.S. states, consumers would pull back on spending on things like restaurants. Based on recent data from JP Morgan on Open Table reservations in states that had ended their UI programs early, that does not appear to be the case.

Further, the robust U.S. labor market mentioned earlier makes it likely that the transition from enhanced unemployment benefits to getting a job should be orderly for many Americans. And when those individuals do reenter the labor force, the jobs waiting for them may feature higher wages, based on the tightness of the labor market and upward pressure in hourly wages documented in recent U.S. monthly employment reports.

One other factor supporting U.S. households is the child tax credit, which is going to come in the form of a cash payment to eligible families between July and December of this year. That could provide a buffer to family finances as enhanced unemployment payments end, providing support to consumers’ ability to spend—and make credit card and auto loan payments.

Looking Ahead

We think it's likely that that the stellar performance of the consumer-related metrics we’ve discussed here will normalize at some point back to more typical levels, especially as people boost discretionary spending on areas such as travel & leisure and entertainment.

We would also note a couple of potential headwinds. The eventual end of rent and eviction moratoriums may mean that many consumers will have to resume expenditures that were forestalled by those pandemic relief measures. Once those moratoriums end, many consumers may reorient funds toward resuming rent payments, with less money available for loan payments. The end of forbearance for student loans and mortgage loans may also have a similar effect.

Conclusions

On balance, we believe performance of the consumer-focused, securitized categories discussed here will continue to be solid, and that normalization in performance will be gradual as we look past 2021. We think the best way to invest with such an outlook is to keep a keen eye on structure and collateral quality while maintaining a focus on real-time data and leading indicators. We believe our approach offers us the potential to earn attractive and robust, risk-adjusted returns in these sectors as cyclical and secular environments evolve.

 

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Glossary Definitions

Asset-backed securities (ABS) are collateralized by a pool of assets such as loans, leases, credit card debt, royalties or receivables. An ABS is similar to a mortgage-backed security, except that the underlying securities are not mortgage-based.

Securitized products (also known as structured products) are pools of financial assets that are brought together to create a new security, which is then divided and sold to investors. 

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